Wednesday, December 14, 2016

Fred Thompson: Steve Novick's First-of-Its-Kind CEO Tax

Fred Thompson checks in with another well researched post (unlike mine)

Portland’s
so-called Business
License Fee (BLF) levies a 2.5 percent tax on the adjusted net profits of
about 43,000 companies operating in the city. Starting in 2018, Portland will impose
a surcharge to this tax on some large, publicly owned C-corporations. The
surcharge will apply to businesses, which are subject to the Dodd-Frank
requirement that they disclose the ratio of their chief executive’s (CEO)
compensation to the compensation of their median employee and which also
have high compensation ratios. Portland’s department of revenue estimates that about
550 Portland businesses will be subject to this reporting requirement. Where reported
compensation ratios are equal to or greater than 100, businesses will pay a 10
percent surcharge on their BLF (2.75 percent tax rate); equal to or greater
than 250 times, a 25 percent surcharge (3.125 percent).

Portland’s BLF generates about
$60 million in revenue per annum. The
municipal revenue office estimates that the >500 businesses subject to Dodd-Frank
compensation-ratio reporting contribute about one-third of BLF revenue, nearly $20
million per annum, and that the
surcharge will boost municipal revenue by $2.5-$3.5 million per year, which
implies that nearly all the reporting businesses will be subject to the
surcharge, at least one-third of them at the 3.125 percent rate.

This is a novel tax experiment.
As Branko Milanović explained: “What
I find quite interesting is that it seems [to be] the first tax that targets
inequality as such.” For Milanović, it’s novel because “it treats
inequality as having a negative externality, like taxing carbon emissions.”
Moreover, it isn’t at all clear how Portland’s experiment will play out, which
makes it interesting, albeit probably still not in itself materially significant.
Policy experimentation is cool, especially elsewhere.

The remainder of this post will
focus on two issues:

1.What is the purpose of this measure? Will it work?

2.Are the municipal revenue estimates realistic?

Portland spends about $30
million per annum on low-income
housing and homeless services. The revenue from the surcharge will be
contributed to fighting homelessness, where presumably every bit will help.
Moreover, this use of the funds, when combined with its source, ought to
reinforce the symbolic power of the measure.

There is an implicit
presumption that the measure will cause businesses (some C-corps, anyway) to moderate
CEO compensation or boost median earnings. No doubt executive compensation
plays a major explanatory role in the explosion in income inequality that has
occurred over the past 30-40 years. Forbes
magazine recently reported that the average annual total compensation for a Fortune 500 CEO was $10.5 million. This
breaks down to $3.5 million in salary and bonus, $3.8 million in other
compensation such as personal perk packages, and $3.2 million from exercising
vested stock options and awards.

However, compared to the
combined total compensation of Fortune 500 CEOs
of $5.2 billion, the $3 million that Portland expects to collect through this
measure looks like a drop in the ocean. Unless a lot other jurisdictions follow
Portland’s lead, it isn’t likely to meaningfully influence corporate
compensation practices, one way or the other.

Furthermore, it is possible that
Portland won’t even collect $3 million from this measure. As is the case with a
lot of things, CEO compensation tends to be characterized by a Pareto
distribution, i.e., 20 percent of CEOs get 80 percent of total compensation.
That implies an average compensation for the 400 CEOs at the bottom of the Fortune 500 list of about $2.5 million
each, well under the $4 million Portland used to estimate the cutoff for the
surcharge. When compared with the average median worker compensation in Fortune 500 companies of about $80,000,
which boosts the cutoff to $8 million, this implies that considerably less than
half of Portland’s top C-corps will be on the hook for the surcharge. Moreover,
looking only at the average median worker entirely omits from consideration the
possibility that Bloom et al. are correct, that
two-thirds of the rise in earnings inequality from 1978 to 2013 was due to increases
occurring between businesses, not within them – let alone all the shadier expedients
mandatory disclosers could avail themselves of to minimize reported compensation
ratios.

1 comment:

Elsewhere, Jonathan Thompson noted in response to my observation that"No doubt executive compensation plays a major explanatory role in the explosion in income inequality that has occurred over the past 30-40 years, "and noted that this claim is false. "The share of income going to the top 1% has roughly doubly according to the most commonly used data from 1979 and is now more than $3 trillion. As you point out the income of the Fortune 500 CEOs is only $5 billion combined and the income of the corporate boards of every corporation on the S&P 1500 is only around $20 billion. Even if those figures started at zero they explain a miniscule portion of the increasing share of income of the top 1% over the last forty or so years."

I agree that he is correct in questioning the supermanager story, noting there are only 500 CEOs of Fortune 500 publicly traded companies – in fact there are only about 3,500 large publicly traded companies in the U.S., down from more than 5,000 in the mid-80s (altogether the census now reports fewer than 10,000 C corporations with 500 or more employees), whereas the real issue goes to the relative increase in the earned incomes of 160,000 households (the top .1 percent).

My observation merely acknowledged Bakija, Cole, and Heim’s (2012) finding to the effect that “that executives, managers, supervisors, and financial professionals account for about 60 percent of the top 0.1 percent of income earners in recent years, and can account for 70 percent of the increase in the share of national income going to the top 0.1 percent of the income distribution between 1979 and 2005.”

Top executives, managers, and supervisors working for publicly held, non-financial corporations did quite well during this period, increasing their share from 1.2 percent to 2.2 percent of total GNY, but their domination of the top 0.1 percent declined almost by half. In 1979 they took home 37 percent of the income earned by the top 0.1 percent of households; by 2005 their share had dropped to 21 percent.

In contrast, financial professionals and managers (mostly not in C-corps) made out like bandits, increasing their share of the total from 0.4 percent to 2.1 percent, while their share of the income of the top 0.1 percent of households nearly doubled (the 25 highest-earning hedge fund managers in the United States took home >$20 billion in compensation in 2012, according to Alpha magazine, 4 times the amount earned by Fortune 500 CEOs)

However, arguably the real winners were executives, managers, and supervisors working for privately held, non-financial enterprises. Their share of total income increased from 0.3 percent to 2.5 percent; they now take home nearly one dollar in every four earned by the top 0.1 percent of households. Most of these businesses are ‘pass-through’ enterprises: their income passes directly to their owners’ personal income tax returns. In contrast the income of C corporations is taxed twice, through corporate income taxes and then again through personal income taxes on dividends and capital gains.

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